1. Risk Management and Basel II
Indian Institute of Banking and Finance

2. How do banks make money? Essentially by taking risk
By playing “term” of funds: Long v/s short.
By playing risk levels- accept lower risk and place in higher risk- play safety as a market mantra
Dispersed source v/s concentrated use.
Trading in the market
Essentially by taking risk

4. Risk Definition and features
Event likely to cause loss/variability/damage to income and reputation
Features:
Fairly known- Cannot be avoided.
Probabilistic and generic
Ascertainable, although not always quantifiable
Essential for intermediation process.
Risk and Reward go together
Interrelated/ Collectively exhaustive but not mutually exclusive
Risk is an opportunity

5. Generic and Unique risks
Industry
Unit/firm/company related
Location specific
Ownership related
Sector specific
HRD/Structure related

6. Sources of Risk Decision ,Indecision Business cycles/ Seasonality
Economic/Fiscal changes
Policy Changes
Market movements
Events
Political compulsions
Regulations
Human resources, skill sets
Competition
Technology
Non-availability of information

7. Types of Risks
Credit: Default/delay: Impacts Solvency-Capacity to service obligation,
Liquidity: Inability to meet committed payments, inability to exit an investment.
Interest Rate: Changes in the market rate causing income variability
Exchange: Fluctuation in currency rates, prices becoming adverse for the company
Market: Interplay of above on trading profits
Legal:
Operational: Failure of Men, Machine, Monitoring, Methods

8. Anti-Money Laundering
The global financial regulatory framework is undergoing important changes…
Basel II
USA PATRIOT ACT
FATF RECOMMENDATIONS
Risk Management
Anti-Money Laundering
Corporate Governance
…and money laundering and corporate governance issues have become entwined with operational risk management

9. Goals of risk Management
Safety and soundness of banks.
Ensuring a level playing field.
Capital Adequacy Ratio
(1) own funds (i.e. available capital and reserves)
(2) risk-weighted assets (i.e. the amount of money the bank has put at risk in the course of its business)
A level playing field !!
Source: BIS

10. More importantly by having
How to manage risk
Hedging
Exposure limits
Reserves and Provisioning
More importantly by having
adequate capital

11. Basel I
IRAC norms- uniform across institutions, products and performance
Capital adequacy- Uniform across the commercial banking- coop banking will catch up shortly

12. Lessons Of Basel I Risk is an opportunity
Better NPA Management- varieties of ways
New Institutions ( ARC) Laws ( Sarfaesi)
Almost all banks and RRBs in good financial health- meet CRAR nomr
Explosion of new- customer centric products
More employment.

13. Basel II Primarily for internationally active banks
RBI will take view on other banks- It is safe that all banks comply
8%on risk weight. But weights and loss estimates differ-
Basel II is capital accord. Other risk management norms will happen
F.M says “ Indian Banks will need additional 60,000 Crores in the next few years”- to meet with growth needs.

14. Three Pillars of Basel II
Supervisory Review
Minimum Capital
Market Discipline
The new Basel Accord is based on Three Pillars
Advanced methods for capital allocation
Capital charge for operational risk
Focus on internal capabilities
Supervisors to review banks internal assessment and strategies
Focus on disclosure

15. Basle II. Minimum Capital Requirements-Pillar 1
Sets minimum acceptable capital
Capital arrived by enhanced approach with credit ratings
External or Public rating
Internal rating
Explicit treatment to operational risk
ALM risk not treated but included in

16. Supervisory Review _ Four Principles- Pillar 2
Banks must attain solvency relative to their risk profile
Supervisors should review each bank’s own risk assessment & capital strategies
Banks should maintain excess of minimum capital
Regulators would intervene at an early stage
Possibility of rewarding banks with better risk management systems.
RBI has already taken steps to conduct supervisory review

17. Market Discipline- Pillar 3
Improved disclosure of
Capital structure
Risk measurement and management practices
Risk profile
Capital adequacy

18. Credit Risk -Approaches

19. Credit Risk Approaches

20. Credit Risk Approaches

21. Computation of Capital
Standardized
No change over 1988
Foundation
No change over 1988
in VaR
Market Risk
Our country
is relatively
advanced
in this area
Advanced
No change over 1988
in VaR

22. Computation of Capital
Standardized
Capital change based on
single risk indicator
Foundation
Capital based on business
lines and industry standards
Operational
Risk
Advanced
Capital based on business
lines and internally
calculated standards

23. Operational Risk Approaches

24. Decision areas for Banks
Choice of methodology and convincing the regulators
IT supports needed
Software requirements
Staff training on compliance
Consultancy requirements
Risk mitigation opportunities
Outsourcing possibilities
New jobs creation
Implementation cost and time

25. BASLE II IS ALL ABOUT A RESPONSIVE AND SOPHESTICATED RISK MANAGEMENT SYSTEM
R = Risk = Function of Uncertainty U
U = Function of Quality Information QI
QI = Function of Accuracy/ Timeliness/
Relevance/ Adequacy A, T, R, Ad
A = Function of IT
T = Function of IT
R and Ad = Function of IT, Management Science, Modeling amenable to establish mathematical relationship

26. Risk Management – a data intensive function
Credit Risk
Market Risk
Operational Risk
Banks
Borrower Data
Guarantor Data
Asset-specific Data
Default Data
Data on Recoveries
External Default Data
Data on Rating and Migration
Macro & Industry Data
Correlation Data
Data on Exchange Rates
Data on Interest Rates
Data on Security Prices
Data on Correlations
Data on Instruments (non-linear)
Loss Event Data
Causal Data
Loss Effect
Key Risk Indicators (KRIs)
Proxies
Risk Inventories
Structured Self Assessment Data
External Data
Transaction Data
Operational CRM Data
Analytical CRM Data
Risk Management Data
Economy & Industry Data

27. Basle Accord and IT
Basle II promises significant business benefits to those who have systems in place to access and utilize far more detailed and precise information
Integration of data on finance, operations and risk management necessary
Opportunity to get out of legacy systems and procedures including IT system
Fundamental rethinking on how a bank’s data and information is provided and controlled
Pillars are interdependent and must be addressed to concurrently

28. Basle Accord and IT Internal Rating based approaches revolve around
Probability of default
Loss given default
Exposure at default
Other parameters
Main requirements would include
Defining and capturing loss data
Capturing and extracting exposure data
Identifying and capturing risk mitigation data
Data issues would be
Sources/ Data types/ Quality requirements and
Granularity (level of data)

29. Basle Accord and IT Operational Risk Management pre-supposes
Framework and systems in data integration
Low frequency-high severity occurrences
Structure for risk management and interaction amongst functionaries
Potential for mitigation, outsourcing and alike issues
Shared facilities feasibility
More synergy and little overlap

31. THANK YOU